Interesting Week in the Energy Sector

Israel increases its war of words over Iran. President Obama refuses to meet with Netanyahu. Libyan terrorists attack the U.S. consulate. Anti U.S. violence breaks out in Egypt. Crude inventories rise significantly higher than expected.

I spent several paragraphs over the weekend noting that the Israel/Iran headlines had slowed to a trickle and maybe that was an indication Israel was going to lighten up until after the election. The day after that article the Israeli headlines exploded with hostility against the U.S. and president Obama and calling for a "red line" on Iran. The headline flurry began with several sources claiming the president had refused to meet with Prime Minister Netanyahu when he is in the U.S. later this month to speak at the UN. This was reported by dozens of sources over the last three days. Today the White House denied published reports saying no such request was made or rejected. The White House also said Netanyahu and Obama spoke by phone for an hour on Tuesday night and reaffirmed that the countries are united in their determination to prevent Iran from obtaining a nuclear weapon. The two leaders reportedly agreed to continue "close consultations going forward." If that does not sound like election posturing I don't know what would. The president realized he was in danger of losing the Jewish vote on his rejection of a visitation request and he had to get in front of the problem with an "official" press release promising continued support.

Netanyahu and Obama are not friends. Obama has snubbed him more than once in speeches and press releases. Once, during a meeting at the White House, Obama became frustrated with the direction of the discussion and he jumped up, abruptly left the room and went to the family side of the White House and sat down to eat with his family, leaving Netanyahu alone in the meeting room. Another time Obama held a press conference two hours before a scheduled meeting with Netanyahu and spelled out his firm disagreement with what Netanyahu was coming to discuss. That is never done since politicians always try to maintain the appearance of mutual concern over the issues and a closing photo op is held where each gets to say a few words. Twice Obama cancelled the photo op because he did not want to give Netanyahu a podium to disagree with him.

The pressure was building on Tuesday morning when Netanyahu criticized the U.S. for failing to send Iran a clear message on what red line would trigger a military response. He was responding to refusals by both Obama, SoS Clinton and Defense Secretary Panetta to draw a line in the sand that Iran could not cross without drawing an attack.

In this instance Netanyahu is correct. Iran has been playing the rope-a-dope for more than a decade. They claim they want to talk then when the talks come they dodge the issues and try to change the subject and eventually drag the talks out to the point where everyone loses interest. The talks end, more threats and sanctions appear and a year later the process is repeated and the entire time Iran is racing to enrich uranium and hide their nuclear installations. The only thing that actually gets their attention is when there is a serious threat of impending action.

The U.S. and the other five nations involved in the latest round of talks have refused to take a hard line on Iran. Russia and China have prevented the group from forcing Iran's hand. However, on Wednesday morning those countries agreed to support a UN resolution critical of Iran's defiance on the nuclear demands. The resolution, which demands that Iran halt all activities that could be used to make nuclear weapons, cannot be enforced by the 35-nation board of the IAEA, even if it is approved. It is just another toothless exercise that will be ignored by Iran.

The only weight behind the document is the growing number of signatories that are choosing sides against a nuclear Iran. Iran is not completely stupid. They see the growing consensus against them and they can calculate how much longer they can get away with their efforts before the international community finally reaches critical mass.

The new resolution comes after the IAEA disclosed new information that Iran has been doing computer modeling of configurations and payloads of nuclear weapons.

The headline war will probably calm down again after today's revelations but we can expect another resurgence after Netanyahu's speech to the UN later this month. He said he is going to give a clear and concise warning about Iran as the greatest threat to world peace.

The Israel/Iran headline war did not materially impact oil prices. However, the new problems in Egypt and Libya did. In Libya a group of well armed individuals stormed the U.S. Consulate in Benghazi. Four people were killed including the U.S. ambassador to Libya, Christopher Stevens. This is the first ambassador killed in over 30 years. The attackers were armed with machine guns, grenades and RPGs. The attack was carried out in force and with precision and planning that suggests it was not just an unruly mob incensed about the YouTube video.

Officials are not theorizing a militant faction calling themselves Ansar al Sharia, translated into "Supporters of Islamic Law" may have been responsible. There are also some reports it was an Al-Qaeda affiliate known as "Al Qaeda in the Islamic Maghreb." After the attack the Al Qaeda leader, Ayman al-Zawahiri, appeared in a video on militant websites confirming the death of his second in command and urged Libyans to avenge his killing.

President Obama announced he was sending marines to Libya to protect U.S. interests and two warships have been tasked to positions offshore Libya.

In Egypt a mob attacked the U.S. Embassy reportedly because of hostility over a movie made in the U.S. that portrays the prophet Muhammad as a fraud. The promoter of the film, Morris Sadek, was an Egyptian citizen but as a result of his work his citizenship was revoked. He now lives in the U.S. as a religious refugee.

While the attack by the mob was highly publicized the government of Egypt quickly denounced it and increased security to prevent any further outbreaks. This was a mob while the Libyan attack was not.

There are some dangerous signs appearing in the Muslim countries and the Arab Spring may ultimately turn out to be a negative force for the Middle East and Northern Africa. I suspect there is more trouble ahead for American interests. President Obama has increased security at all U.S. installations and facilities around the world.

Armenia warned Azerbaijan it was ready for war after an Azerbaijan soldier who murdered an Armenian soldier with an axe was pardoned and promoted. The soldier was extradited from Hungary, where he was serving a life sentence in the 2004 killing. Upon his return he was promoted to the rank of Major, given a house and eight years of back pay along with a hero's welcome. The two countries are still technically at war since they never signed a peace deal since the 1994 ceasefire and there are regular cross border firefights along the front lines.

While this is not related to the U.S. there is oil production in Azerbaijan that could be impacted if the countries go back to war.

Oil Inventories

In the weekly EIA inventory report there was a big surprise. Analysts were expecting a decline of -2.9 million barrels on top of the -7.4 million barrel decline last week. Instead we saw a gain of +2.0 million barrels. This was a total shock to analysts. Everyone believed the slow restart after Isaac would amount to a lack of oil making its way to the refiners. Pipelines were closed and some platforms were still curtailed a week after Isaac passed.

The only material factor was a continued decline in refining capacity utilization to 84.7% from the 91.2% before Isaac. Analysts believe the decline in utilization, likely a result of the continuing power problems in Louisiana the week after Isaac, was responsible for a decline in production leaving more oil in inventory. We also saw a pickup of 530,000 bpd in imports as those tankers delayed by the storm began to offload. That added 3.5 million barrels to inventories.

Inventory Snapshot

Crude inventories refuse to decline into the historical five year range although they are close. U.S. production has been down about -750,000 bpd as a result of the storm and at 5.53 mbpd there was only a minor +40,000 bpd increase over the prior week. Once that production recovers, as it should this week, we should see inventory numbers rocket higher.

Crude Oil Inventory Chart

Gasoline inventories declined by -1.2 million barrels as a direct result of the drop in refining. The demand for gasoline fell by 418,000 bpd now that the summer driving season is over. Gasoline demand at 8.7 mbpd was the lowest level since the week of July 20th and should only decline from here.

Gasoline prices nationally rose to $3.84, up another 7 cents, and topped $4 in many areas. Once the Gulf is completely restored we should see those prices begin to fall sharply.

Gasoline Inventory Chart

Distillate demand recovered slightly by +50,000 bpd to 3.27 mbpd but is still about 300,000 bpd below pre Labor Day levels. In theory demand should increase as we approach fall and the holiday season and trucking companies increase loads and driving. Time will tell. We are in that gray area between summer and Thanksgiving so I don't expect much of an increase soon.

Distillate Inventory Chart

Gasoline prices rose to $8 in NJ and PA but it was not due to crude prices. More than 50 Lukoil stations jacked up the prices in a protest to what they say is unfair pricing practices by Lukoil North America. Dealers said it was not uncommon to see competitors selling gasoline at retail for less than what Lukoil charges them at wholesale.

Lukoil is Russia's second largest oil producer. The first Lukoil branded stations opened in the U.S. in 2003 and now there are more than 500. Lukoil said they use a zone pricing program and it was perfectly legal for them to sell gas to individual franchisees locations at nonstandard prices. Retailers claim Lukoil sold the very same gasoline to competitors in the same area for as much as 25 cents less than what the franchised stations had to pay.

Tropical Storm Nadine (14) has formed east of Puerto Rico but the track is northeast and it is not expected to come anywhere near the U.S. coast. With six weeks to go in the hurricane season there is always a chance for another storm to cause trouble in the Gulf.

On Sunday I reported about Shell starting a drilling project in the Arctic. I discussed how they were going to handle the sea ice and their months of planning for this effort. After only ONE DAY of drilling the company had to abort the effort and move the rig off the location because of sea ice. Shell said approaching sea ice forced the ship to move off the location but once the ice had passed they would reconnect and restart the drilling process. Excuse me but this is summer. What do they think is going to happen in the winter?

Shell only has a permit to drill 1400 feet and only until September 24th. My thought here is "Why bother?" Shell has requested an extension but the arctic containment system for containing blowouts has not arrived onsite so the extension will probably be denied.

Transocean Offshore (RIG) announced it has a agreement to sell 38 shallow water drilling rigs to Shelf Drilling International Holdings for $1.05 billion. This is a partnership that includes Champ Private Equity and Line Rock Partners. The sales price will be $855 million in cash and $195 million in seller financing. Transocean will take a Q3 charge of $2.9 billion after taxes. Transocean has been trying to sell these rigs for a couple years and has mentioned the $1 billion target several times in recent quarters. Annual revenue will decline by about $1.15 billion and cost will decline by -$800 million as a result of the sale.

Transocean also sold $1.5 billion in debt to fund the construction of four high specification drillships.

Transocean also said it was in talks with the government to settle the claims over the Deepwater Horizon disaster for $1.5 billion. Items still remaining to be settled was the extent of the coverage of the settlement towards water quality issues and the time allowed for payment of the $1.5 billion. This would be a great deal for Transocean since they took a total of $2 billion in charges to cover a possible settlement. However, the deal is not done and anything can happen.

In worse news the Brazilian court upheld its ban on Transocean and Chevron from operating in Brazil until a $20 billion spill trial is over. Transocean had tried to get an injunction to block the ban but was unsuccessful. Prosecutors are demanding Chevron and Transocean pay $20 billion for a 3,600 barrel oil spill in 2011. Brazilian regulator ANP tried to halt the ban but was unsuccessful. Transocean has 10 rigs in Brazil with 7 leased to Petrobras and one each to Chevron, BP and Vanco. A shutdown of Transocean will dramatically impact the Petrobras plan to increase production and could set them back a couple years. This would have ripples throughout the oil service business in Brazil since all the equipment contracted to support the ten year effort on those ten rigs would have to be cancelled. Petrobras is at the beginning of a $237 billion development program and they don't need this hassle by prosecutors over an insignificant 3,600 barrel spill. Transocean has not yet been served with the injunction to halt operations within 30 days. The clock does not start until they are served. Transocean will be forced to claim force majeure and rig revenue on those rigs would halt. Transocean gets 11% of its revenue from Brazil.

Plains Exploration and Production (PXP) announced it was buying $5.5 billion in Gulf assets from BP and $560 million from Shell. The Shell portion was an interest in a BP lease that was co-owned by Shell and BP. This makes PXP one of the largest landowners in the Gulf of Mexico. JP Morgan, Bank of America, Barclays and Citigroup headed a group of banks providing $7 billion in financing for PXP. That is $2 billion more than the market cap of PXP.

PXP will gain more than 66,900 bpd of existing production plus interests holdings of BP. BP will get cash to use towards the anticipated $25 billion fine by the government over the Deepwater Horizon disaster.

The FOMC decision on Thursday is going to be highly influential to the price of oil. If they announce some new QE program we will see the dollar collapse a little further and commodities rise. If they don't announce QE then the dollar will rise and commodities fall. Eventually, regardless of the decision the lack of demand in the fall will cause oil prices to decline. However, the new worries over the Middle East and Northern Africa will provide support. It will be a precarious balancing act until some headline disrupts that balance and prices move as a result. WTI has resistance at $98 but then a clear path to $105. Support is currently $94 followed by the high $80s.